My Macro-style Trend Investing Strategy

When it comes to investing, I love clear rules and simplicity. I don't mind being different from the conventional wisdom. I also have a good grasp on market history, I understand what goes up will come down, and I'm comfortable with losses because of my extremely high savings rate and long time line.

Reading lots about market history across the entire globe and going back to the 18th century has significantly influenced my investment philosophy. I don't believe in using just one strategy for my entire portfolio. I also welcome leverage to amplify positive price movements.

Being several years away from 30, my investment timeline is at least 60 years based on current life expectancy. I don't care what happens this year or five years from now because it's largely irrelevant in the big picture.

Global buy-and-hold could work well for me, like it generally does for anyone with the discipline to stick with it. But, in my quest for being different and willingness to experiment with my own money, I've decided to invest my own portfolio in a very different strategy.

It's important to emphasize that this is not an endorsement of doing something other than buy-and-hold, nor a criticism of buy-and-hold. Pursuing something different means conviction of its benefits, sound knowledge of the strategy, and strict adherence to the rules. Whether you buy-and-hold, or dividend invest, or anything else, rules are important.

Investing is not a game where you dabble in and out of strategies as it suits. It's a commitment to your future well-being with continual development as you learn.

Macro-style Trend Investing

Macro:  very large in scale, scope, or capability; of or relating to macroeconomics
Trend:  the general course or prevailing tendency; drift
Invest:  to put (money) to use, by purchase or expenditure, in something offering potential profitable returns

Macro-style trend investing is what it sounds like: purchasing investments which are large in scale and drifting upwards.

With this strategy I generally don't invest in individual stocks, I don't necessarily buy what is the cheapest, and I follow very specific, but broad rules to determine what I can purchase, when I can purchase, and when I must sell. I also pay attention to tax triggers and trading costs.

Background & Criticisms of Trend Investing

Trend investing is actually a small corner of the retail investing world. When I mention it, people often look confused. It is wildly different from the more popular strategies out there: Boglehead indexing, Buffett-Graham value investing, the gold bugs, Lynch's investing in what you know, and the good old dividend crowd.

These other strategies are much easier to wrap your head around and are very talked about in the investing world. They are all based on popular paradigms and prove difficult to dispute because of herd mentality.

Pure trend on the other hand seems faddy and reckless. Using moving averages, ignoring current valuations, technical charting (gasp!). Some of the most popular jabs in the investing world include poking fun at "chartists".

But the fact is technical analysis has a long history and there are many very wealthy technical investors. I don't necessarily mean highly complex strategies, but basic trend combined with fastidious discipline. Jesse Livermore was a famous early-1900s trend investor who made, lost, made, and lost fortunes worth billions in today's money. Martin Zweig was a more recent example of proficient pure technical investing. Today there are a few technical investors who are billionaires: David Harding, Cliff Asness, Paul Tudor Jones, and John W. Henry (the Red Sox owner) come to mind.

Many of the original trend investors tended to be loners, working in small offices and being intensely private about their approaches to investing. For them, freedom from "noise" was an important element of their success. Successful technical investing requires extreme discipline. Some of the newer big trend investors have become more public because of the "celebritism" surrounding the money management business.

While there are many popular versions of trend investing, many of the criticisms involve day-trading, or similar short term trading. I believe these strategies are poorly thought out; the taxes and trading costs are likely to eat you alive even if your theoretical performance should be good. But that doesn't mean you should throw out the baby with the bathwater and ignore all versions of trend investing.

In macro-style trend investing positions are bought and held for months, if not years. Generally new contributions can be used to buy into existing positions rather than looking for a new signal on a new product. Trend investing is just a set of rules which tell when an asset is acceptable, and when it must be sold.

Risk management is another important aspect of trend investing. Limiting position sizes, continually assessing risk in each position, and using stops are all important.

Converting Academic Research Into An Investment Strategy

The strategy that I developed is unique to me. But that doesn't mean it's purely my own creation. The strategy is based off of work and research done by Antonacci, Jegadeesh, Titman, Faber, Fama, Asness, Covel and other academics or industry professionals.

The difficult part of momentum and trend research is converting that basis of knowledge into actionable strategies which should provide pervasive and reliable returns. That's where the development of my own investment approach comes into play.

The challenging part is using these academic principles without having the powerful back-testing tools available to large institutions. Also, many of the products I use have only been around for 10 years at most. In a broader sense, Antonacci in particular has done a great job of demonstrating the power of momentum going back to 1974. Other academics have now gone back hundreds of years, even using old bond market data.

In truth, I don't believe there is a perfect investment strategy that exists. Back-testing, while important, can always be tweaked and prodded to find anomalies. However, using the principles, I believe there exists a potential for great performance.

There's also some wisdom in running more than one strategy. I personally divide my portfolio into two smaller portfolios. It keeps a clean separation and reduces the temptation to peel money away from the strategy that performed the poorest in the more recent past.

My 10 Rules: Macro-style Trend Investing

1. Invest in lower cost broad country, region, or asset class index ETFs as appropriate, large cap stocks can be used if they are representative of the asset class and the index ETF is not liquid;
2. Except for bonds, U.S., EAFE, or Emerging index funds no new position can be more than 20% or less than 10% of the portfolio;
3. New purchases must be trading above a predefined moving average or breakout, longer timelines are better at eliminating noise;
4. Avoid new purchases of broad indices with extremely high Shiller-CAPE ratios even when they're in an uptrend;
5. Each position must be sold when it trades below the predefined moving average;
6. Use stop-loss orders where you can to avoid doubting sell signals;
7. Each position should be held until sell signal, except when partially sold to manage risk;
8. Hold no more than six positions in the total portfolio to keep costs down and the portfolio easy to manage;
9. Consider using leverage with a wide safety margin, if available at a low cost;
10. When no eligible positions exist, hold short-term government bonds, tax-efficient bonds, or cash.

What the Portfolio Looks Like

The end result of this strategy is you would generally hold somewhere between two and six broad positions in the portfolio. Sometimes the portfolio will be in all cash or bonds.

You would enter a position when it hits a new high based on one timeframe and potentially add to that position if it hits a new high on a longer timeframe. The inverse happens when selling.

While draw-downs will occur, their overall effect on the portfolio will be limited due to the sell signals. Price breakouts, moving averages, and position risk management can offer a nice amount of protection from large and extended drawdowns. While whip-saws occur in approximately one-half of all trades made, on the big moves the new entry price will be lower than the price the position was sold at.

It's impossible to perfectly time the markets, but using the Rules it's possible to sell before getting hit with long bear markets and buy only months after the markets turned around. In my view that's a pretty reasonable compromise.

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